The concept of business valuation has been around for more than a century, but many people still find it difficult to grasp. We’re here to tell you that it’s actually surprisingly simple! Business value is created when a company grows, and their earnings from their capital is more than their cost of capital. That’s it!
What’s your business worth?
A valuation of your business was previously known to be costly and very time consuming. It would often involve contacting financial advisors, looking through accounts and analyzing numbers. In general, there are three main areas you could base your business valuation on: assets, market value or fundamental value. Asset-based valuation does not apply to all business types, and a market value really only works when there are enough similar businesses to compare your company to. When looking into fundamental value approaches, the most common method is the discounted cash flow model (DCF). A more modern approach to business valuation is instead to discount future excess returns. This is based on available accounting data, which many perceive to be more stable and readily available than cash flow measures. By finding out what your business is worth today, you will be able to track change from year to year, plan for an increase of value of your business and influence the right actions.
The key? Objectivity!
If history has taught us one thing, it’s that it can be disastrous to neglect the basic concept of business valuation. Both the Internet bubble and the most recent recession of 2008 can both be traced back to misappropriation of valuing a business. To further add to the list of catastrophes, the Japanese economic breakdown in the 1990’s was, in essence, a consequence of incorrect business valuation. Let’s not have that history repeat itself! A major flaw that contributed to these crisis was the lack of an objective valuation. If you try to value your own company, it’s going to be like asking a hardcore fan about their favorite team – it’s difficult for both to take a step back and look at the situation objectively.
Today’s action – tomorrow’s value
Remember that business value is created when the return on capital is more than the cost of capital. Essentially, it’s like a health check for your company. Regardless if you’re planning on adding shareholders, strategizing about growth opportunities or looking to buy out partners, you will want to have an updated business valuation at hand. More times than not, people don’t think about business valuations before they need one. Those situations may be quite stressful, and the extra pressure of uncertainty is unnecessary. By valuing your company today, your future value will be easier to determine, track and benchmark against.
The beauty of a business valuation is that nothing is set in stone. If you don’t like the numbers that you see – change them! Record and trace key numbers, educate management and develop an action plan to reach your goal value. By getting a business valuation, you will clearly see which areas need extra care. Setting goals and knowing where you want to go is half the battle.
Decide tomorrow’s value by knowing today’s value!